Frank, now 62, and his wife, who we’ll call Elora, bought their southern Manitoba farm 32 years ago. By the time Frank’s brother Bob joined the operation 20 years ago, Frank and Elora had 1,280 ares of personally owned land.
Frank and Bob incorporated the farm in 1981, bought 640 more acres of land and expanded their cattle herd.
Frank will retire this year, taking his Canada Pension Plan benefits early and earning an additional $15,000 doing some seasonal work for a neighbouring farmer before fully retiring at 65. Bob will continue to farm full time for the next seven years and will be full owner of the farm corporation.
Don Forbes, a farm financial planner with Don Forbes & Associates/Armstrong & Quaile Ltd. of Carberry, Man., worked with Frank and Elora to complete the winding up of their farming assets and the division of the farm corporation’s assets. At the end of 2011, the brothers agreed that the farm had net equity of $1 million. From that, the restructuring could begin.
Bob doesn’t want to borrow money to buy Frank’s share of the corporation. The corporation has $300,000 in cash, so for the next seven years, Bob can rent any land that Frank and Elora don’t sell.
In retirement, Frank and Elora want to be able to maintain their modest spending of $42,000 per year ($3,500 per month) on their living expenses, plus another $12,000 per year for travel. And, they want $300,for new house.
What to do? Start by selling 320 acres of the jointly owned farm land for $600,000 ($1,875 per acre), said Forbes. The property will be eligible for the Qualified Farmland Capital Gains Tax exemption, so the proceeds will be tax-free. An Alternative Minimum Tax payment will be required in 2011, but it can be used as a tax credit on the income tax due on a $300,000 dividend payment from the corporation in 2012 for construction of a new house, said Forbes.
When Frank sells his 50 per cent interest in the corporation, he will receive a $300,000 cash payout designated for mutual fund investments. It will include a $196,000 non-taxable return of capital and the corporation’s capital gain. Then the balance of the cash payment will be a taxable dividend that will attract a bill of about $65,000. But if Frank uses his $40,000 of RRSP space, the bill will be cut to $45,000. Then the balance of the corporation’s holding will be 160 acres of land that can be sold to Frank and Elora for $200,000, said Forbes
Assuming that Frank comes out of these transactions with about $225,000 — depending on the RRSP rollover — to spend or invest, he can put $60,000 into a cash reserve in a so-called high rate savings account, $20,000 into his TFSA, $20,000 into Elora’s TFSA, $40,400 into Elora’s RRSP with the tax credit going to Frank and the balance of $85,000 invested in a non-registered account.
By adding to their RRSPs, Frank and Elora will generate a base for future income. In 2012, these RRSP investments will generate handsome refunds, because Frank will be in a 51 per cent tax bracket. Frank and Elora will each qualify for a $2,000 annual tax credit on pension income. RRIF payouts qualify. Then the balances will be taxed at a 26 per cent rate so that, when each partner is 65, Frank can get $400 per month for 20 years from $67,000 invested and Elora $400 for 25 years from $88,000 invested at six per cent.
If each partner makes maximum contributions to portfolios, then Frank and Elora would have $276,000 in assets by age 75. They will pay tax on distributions from all portfolios, but surplus funds can be rolled into TFSAs to a limit of $5,000 per year plus any unused space.
If the couple takes $3,500 per month from their accounts growing at six per cent per year their money will last forever. There will be as much as $500,000 in their combined TFSA accounts, while the sale of additional acres of land could wring still more money out of the farm.
Frank can count on 2012 retirement income of $2,293 per month consisting of $543 from CPP (after an approximately 5.5 per cent reduction for each year before age 65 he starts benefits), $500 from rental of farmland, and $1,250 per month from off-farm work. For more money to cover living expenses of $3,500 per month, Frank and Elora can take money from their off-farm investments.
In 2014, when Frank is 65, he will get $543 from CPP, $540 per month from Old Age Security and $500 from farm rental for total pension income of $1,583 per month. He can add investment income of $400 to bring the total to $1,983. In another five years, Elora will be 65 and can draw $540 from OAS and $400 per month from her investments. The family total, $2,923, will be less than estimated living expenses but can be covered with money from non-registered investments.
Forbes suggets that funds from the corporate unwinding be invested as follows: 40 per cent to a balanced growth and income fund, 40 per cent to a Canadian dividend fund, and 20 per cent to a global growth fund. If interest rates were to rise dramatically, or if the global economy were to go into a tailspin, then of course this 40/40/20 balance would need to be revised. In retirement, Frank and Elora might find time to study capital markets. It’s a fascinating field with the ability to generate financial rewards. †